What Are NPV and IRR? © 2021 Walden University, LLC. 1 What Are NPV and IRR? Program Transcript [MUSIC PLAYING] NARRATOR: The language of business is accounting. It can help you know how to move assets, when is a good time to invest in a project, and more importantly, when the time is not right. In many organizations, the accounting department is responsible for assembling their reports. However, a manager will be tasked with understanding the information gathered in those reports and making decisions based on that information. It is crucial that you have a solid understanding of accounting terms and concepts, so you can communicate with the financial team effectively. When an organization is looking to invest in a project, leadership needs to know the project's profitability potential. This is measured with net present value, or NPV, and the internal rate of return, or IRR. While both of these calculations are used to assess profitability, they express this information in different ways. Let's examine net present value, or NPV. Its formula provides a calculation of how much an investment is worth in today's money by taking into consideration the timeline for the investment. In the formula, we note that NPV equals the net cash inflow over time. Time is represented by t and is divided by the interest or discount rate, or r. The process of calculating NPV requires four elements, all cash inflows, all cash outflows, the discount rate, and the number of periods for t. Once we have that information, we can calculate the present value of each cash flow. Adding the present values or PVs of all inflows and outflows identifies the NPV. Once we know the NPV, we can determine if an investment is worth taking. As a general rule, an investment is acceptable if it has a positive net present value and should be rejected if the NPV is negative. When we calculate the NPV of a project, we must take into consideration the opportunity cost of capital. The amount of money spent on one investment means an organization will not be able to spend that money on other projects. A company may evaluate multiple opportunities based on the NPV and choose the effort that will benefit the organization the most. What Are NPV and IRR? © 2021 Walden University, LLC. 2 For an example of NPV, consider a company building a new state of the art factory for manufacturing an electric vehicle. This innovative factory will save money over the long run by being more energy efficient and producing the existing product for less money. However, it will cost $150 million to build. Each year, the new factory will make $70 million. Let's see if the NPV is positive or negative. In one year, the company will have a cash outflow of 150 million to build the factory. However, in the same year the organization's cash flow will be $70 million, which is discounted by 9% or 0.09 to the power of 1 for the fir.

1. What Are NPV and IRR?
© 2021 Walden University, LLC. 1
What Are NPV and IRR?
Program Transcript
[MUSIC PLAYING]
NARRATOR: The language of business is accounting. It can
help you know how to
move assets, when is a good time to invest in a project, and
more importantly, when the
time is not right. In many organizations, the accounting
department is responsible for
assembling their reports. However, a manager will be tasked
with understanding the
information gathered in those reports and making decisions
based on that information.
It is crucial that you have a solid understanding of accounting
terms and concepts, so
you can communicate with the financial team effectively. When

2. an organization is
looking to invest in a project, leadership needs to know the
project's profitability
potential. This is measured with net present value, or NPV, and
the internal rate of
return, or IRR. While both of these calculations are used to
assess profitability, they
express this information in different ways.
Let's examine net present value, or NPV. Its formula provides a
calculation of how much
an investment is worth in today's money by taking into
consideration the timeline for the
investment. In the formula, we note that NPV equals the net
cash inflow over time. Time
is represented by t and is divided by the interest or discount
rate, or r. The process of
calculating NPV requires four elements, all cash inflows, all
cash outflows, the discount
rate, and the number of periods for t.
Once we have that information, we can calculate the present
value of each cash flow.
Adding the present values or PVs of all inflows and outflows
identifies the NPV. Once

3. we know the NPV, we can determine if an investment is worth
taking.
As a general rule, an investment is acceptable if it has a
positive net present value and
should be rejected if the NPV is negative. When we calculate
the NPV of a project, we
must take into consideration the opportunity cost of capital. The
amount of money spent
on one investment means an organization will not be able to
spend that money on other
projects. A company may evaluate multiple opportunities based
on the NPV and choose
the effort that will benefit the organization the most.
What Are NPV and IRR?
© 2021 Walden University, LLC. 2
For an example of NPV, consider a company building a new
state of the art factory for
manufacturing an electric vehicle. This innovative factory will
save money over the long
run by being more energy efficient and producing the existing
product for less money.

4. However, it will cost $150 million to build. Each year, the new
factory will make $70
million. Let's see if the NPV is positive or negative.
In one year, the company will have a cash outflow of 150
million to build the factory.
However, in the same year the organization's cash flow will be
$70 million, which is
discounted by 9% or 0.09 to the power of 1 for the first year.
When the initial investment
of 150 million is subtracted from the PVs for each of the three
years, we see a positive
cash flow by the end of year three of $27,190,627. Only
positive NPVs should be
considered for investment.
The other way to evaluate a project's profitability is through the
internal rate of return, or
IRR. It is important to note that with IRR, the discount rate
makes the net present value
equal to zero. The purpose of IRR is to find the interest rate that
equates the initial
investment to the sum of the PV of the future cash flows. The
point at which the initial
outlay of cash equals the future cash inflows is the IRR.

5. It is expressed as a percentage. Looking back to the electric
vehicle factory with an
initial investment of $150 million and 70 million in returns each
year, we calculate an
IRR of 18.91%. When IRR is calculated manually, it takes
numerous attempts to reach
the point of NPV equaling zero. The easiest way to compute
IRR is to use a
spreadsheet.
Step one, on the spreadsheet, we placed the initial investment of
150 million in the first
cell. Then next to that cell, we entered the three positive cash
flows. Step two, the
spreadsheet can use these numbers to calculate the IRR. The
IRR function is built into
most spreadsheet programs. However, the way you enter the
function may differ in
each program.
To use the function, choose a cell, and type the equal sign, and
then type IRR. Choose
the IRR function. We will then need to enter the values of all
cash flows, in this case,
cells A1 to D1, or as A1:D1, and then hit Enter. 18.91% will
then appear. Both NPV and

6. IRR are helpful when making decisions about investments. The
NPV provides a
decisive amount, while the IRR offers a percentage. It is critical
for a manager to
What Are NPV and IRR?
© 2021 Walden University, LLC. 3
understand how these techniques can help you evaluate where
company funds are best
invested.
[MUSIC PLAYING]
What Are NPV and IRR?
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